Question

QUESTION 6 You discover a technical ‘anomaly’ in the US stock market. You find that stocks that go up X% or more 2 days in a row have an expected alpha of X/100% the following day (for example if a stock goes up 6% and 9%, then the next day its expected alpha is 0.06%). Suppose stock A has a BID-ASK spread of 0.2%, and has gone up 10% and 15% percent in the last 2 days. What is your expected profit (in dollars) if you choose to implement your strategy and take a $1000 position in the stock for one day?

Answer 1

i) $98

ii) $148

iii) -$1

Step-by-step explanation:

The BID-ASK price = 0.2% i.e. the market spread

If stock A has gone 10% and 15% percent in the last 2 days, following the discovered technical anomaly the next day the alpha will be

= 10% / 100%

= 0.1%

Calculate your profit If you take a $1000 position in the stock market for one day

i) assume you take a buy position on day 1 ( 10% )

Your expected profit = ( 10% - 0.2% ) * $1000 = 9.8% * 1000 = $98

ii) assume you take a buy position on day 2 ( 15%)

profit = ( 15% - 0.2% ) * 1000 = $148

iii) assume you take a buy position on day 3 ( 0.1% )

profit = ( 0.1% - 0.2% ) * 1000 = - $1 ( you will make a loss )